On August 1, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Germany.1

Germany’s economic rebound of 2010-2011 gave way to weakening momentum during the course of 2012. While exports to non-European trading partners began to recover by mid-2012, in line with improved prospects in the United States and emerging economies, exports to the rest of the euro area continued to decline as the recession in the region continued. Consumption grew robustly as German unemployment remained near post-reunification lows and wages rose well above inflation. Business investment however continued to closely track the decline in exports to the euro area, leading to a contraction in activity in the last quarter of 2012, before stabilizing in the first quarter of this year.

The outlook for the remainder of 2013 and next year is heavily dependent on a gradual recovery in the rest of the euro area and a sustained reduction in uncertainty. Consumption is expected to continue to expand robustly this year given favorable labor market conditions and wage agreements. Exports to the euro area are expected to recover only gradually. Uncertainty is expected to continue to have an amplifying impact on investment through the end of the year and assumed to diminish subsequently. Growth for 2013 as a whole is thus projected at around 0.3 percent, reflecting still below potential growth in the second half of the year. Growth in 2014 is projected to return to potential.

This baseline outlook is subject to a number of interrelated and mutually reinforcing downside risks. Given its high degree of trade openness, Germany is highly susceptible to a slowdown in external demand and/or elevated financial stress. At the regional level, euro area shocks could be transmitted via trade and financial channels. At the same time, the interaction between weaker economic activity and elevated financial stress in the euro area could be mutually reinforcing, owing to already strained balance sheets in a number of countries, and be further exacerbated by waning confidence or heightened uncertainty. A significantly weaker German outlook would in turn affect both regional and global growth prospects, primarily through the trade channel. Policy uncertainty regarding the roadmap and key elements of reforms to the euro area architecture, prospects for a recovery of activity in the euro area, and the still unsettled regulatory and supervisory landscape for the financial system, represent another factor which could magnify the effects of the intertwined shocks discussed above. In terms of risks of a more medium-term nature, an extended period of low growth could lead to hysteresis-type effects by lowering potential growth. Risks to domestic financial stability may surface owing to, for example, a shock to confidence by depositors and creditors in systemically important institutions, which by increasing risk aversion, could disproportionately suppress economic activity and trigger contagion more broadly.

Executive Board Assessment

Executive Directors commended the German authorities for prudent economic management, preserving strong domestic fundamentals, healthy balance sheets, and financial system soundness. Directors noted that these positive developments have provided an important anchor of regional stability. Meanwhile, uncertainty surrounding policies and prospects for the euro area is weighing on business investment and exports to the region. Directors stressed that policy priorities in the near term should aim at reducing this uncertainty to rebuild confidence and managing downside risks to the outlook. They also emphasized that, given the size of Germany’s economy and its large external imbalances, stronger and more balanced growth in Germany is critical to a lasting recovery in the euro area and global rebalancing.

Directors commended the authorities for achieving national and supra-national fiscal targets. They welcomed the modest loosening of fiscal policy to help generate growth in domestic demand. Most Directors supported the current policy stance for this year, although some saw scope for a more proactive stimulus, given the significant risks to the outlook. Going forward, Directors welcomed the authorities’ intention to avoid over-performance on fiscal consolidation, and encouraged a recalibration of policy should growth fall short of expectations. Ensuring fiscal sustainability remains a long-term objective in light of demographic pressures.

Directors welcomed the improved soundness of the banking system, the introduction of a macroprudential framework, and progress in implementing the recommendations of the Financial Sector Assessment Program Update. They encouraged the authorities to build on these achievements and remain vigilant to vulnerabilities, including those related to a still unsettled regulatory landscape and the dependence on wholesale funding by some large banks. Key priorities are further improving capital buffers, profitability, and efficiency of the financial system, and facilitating the adjustment of business models ahead of new international and European regulatory requirements. Directors also urged continued efforts to strengthen the surveillance of large cross-border banks and enhance coordination with supervisory authorities in key financial centers.

Directors saw an important role for Germany in facilitating the advancement of the financial reform agenda at the regional level. In this context, they pointed to the merits of further aligning national legal and regulatory initiatives with European proposals, and of reducing the fragmentation of deposit insurance mechanisms and banking systems more broadly. Directors looked forward to German leadership in articulating a clear, coherent roadmap toward achieving European financial sector initiatives.

Directors welcomed the authorities’ continued commitment to help forge a robust architecture for the economic and monetary union (EMU). They stressed that a clearly-communicated longer-term vision for closer economic and financial integration among EMU member countries would provide a crucial anchor to the expectations of households, firms, and the financial system.

Directors emphasized the need to sustain reform momentum to raise the economy’s growth potential and promote a more balanced economy, which will contribute to a further reduction in external imbalances. They welcomed recent initiatives to increase labor force participation, and encouraged steps to raise real wages by lowering the tax burden. Additional efforts are also essential to accelerate the pan-European integration and harmonization of energy and transportation networks, improve the productivity of the services sector, and broaden the sources of financial intermediation.

6/ Reflects Germany's contribution to M3 of the euro area. Data for 2013 refer to April.

7/ Data for 2013 refer to April.

8/ Goods and services.

9/ Trade in goods, including supplementary trade items.

10/ Based on relative normalized unit labor cost in manufacturing.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.